A fresh look at Optimum Currency Area theory
A large body of the economic literature on the European Monetary Union (EMU) has been based on cost-benefit analysis of the desirability of a single currency and under what conditions a country might wish to participate. Little has been written on under what circumstances a country may wish to leave.1 However, if EMU is meant to last, it might be worthwhile to consider the case of failure in order to avoid it. The decision to join a monetary union is typically addressed in terms of Optimum Currency Area (OCA) models, which focus on static, steady-state alternatives. From this point of view, a country should opt for the euro if the expected benefits of currency unification exceed its costs or disadvantages. Otherwise, it should stay out. However, if the net benefits are not static, the logic of this argument must be inverted: if the costs of being a member of the currency union were to increase beyond the perceived advantages, a country may wish to leave. Some amount of inertia would be provided by the transitional changeover cost of moving back to a national currency, but if the total balance of pros and cons is narrow and uncertain, membership in EMU could become volatile. An example for unstable participation in European institutional arrangements is monetary co-operation in the 1970s: between 1972 and 1978, there were twelve withdrawals and rejoinders to the Basle Agreement, known as ‘the snake’ (Collignon 1994). This might not qualify as a reference for EMU, given that the degree of institutional commitment between participants was low, and it cannot be compared with the later European Monetary System (EMS), let alone EMU. After all, a monetary union is defined by the institutional substitution of national currencies by a single currency. But from the perspective of OCA analysis, one must explain whether the net balance of advantages from EMU can be stable.